The attached note looks at five great charts on investing for income (or cash flow). The key points are as follows:
- The collapse in interest rates has made it harder for many relying on interest on bank deposits for income.
- These five great charts help illuminate key aspects of investing for income (or cash flow): there are alternatives to bank deposits for income; the gap between yields on different assets provides a guide to relative value; shares can provide stronger growth in income with less volatility than bank deposits; a high and sustainable income yield from an investment provides security; and yield is a guide to future returns.
Since I first looked at “Five great charts on investing for income” two years ago, the Australian cash rate has halved, 10-year bond yields have fallen by two thirds and interest rates have resumed falling globally. Ever lower interest rates and periodic turmoil in investment markets provides an ongoing reminder of the importance of the income (cash) flow or yield an investment provides. The environment of low interest rates is challenging for those relying on investment income to fund their living costs and investing for income can seem daunting. So this note looks at five charts I find useful in understanding investing for income.
Chart #1 Alternatives to bank deposits
The income yield an investment provides is basically its annual cash flow divided by the value of the investment.
- For bank deposits, the yield is simply the interest rate, eg bank 1-year term deposit rates in Australia are about 1.3% and so this is the cash flow they will yield in the year ahead.
- For ten-year Australian Government bonds, annual cash payments on the bonds (coupons) relative to the current price of the bonds provides a yield of 1% right now.
- For corporate debt, it’s a margin above government bond yields and depends on the riskiness of the company but is currently averaging around 2% in Australia.
- For residential property, the yield is the annual value of rents as a percentage of the value of the property. On average in Australian capital cities it is about 4.2% for apartments and around 2.8% for houses. After allowing for costs, net rental yields are about 2 percentage points lower.
- For unlisted commercial property, yields are around 4.9%.
- For infrastructure investment it averages around 4%, but franking credits could add 0.45% to this.
- For a basket of Australian shares represented by the ASX 200 index, annual dividend payments are running around 4.3% of the value of the shares. Once franking credits are allowed for, this pushes up to around 5.6%.
The next chart shows the yield available on a range of investments both now and in December 2009 for comparison.
Source: JLL, Bloomberg, AMP Capital